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Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comFlytec’s ManagementWhat is even more problematic than Flytec’s purported purchases,however, is the company’s provenance. Flytec’s hometown ofCiudad del Este is one of Latin America’s great money-launderinghubs. According to the U.S. Embassy in Paraguay:“Ciudad del Este, on Paraguay’s border with Brazil andArgentina, represents the heart of Paraguay’s undergroundor “informal” economy. The area is well known for arms andnarcotics trafficking and violations of intellectual propertyrights with the illicit proceeds from these crimes a sourceof laundered funds. Some proceeds of these illicit activitieshave been supplied to terrorist organizations.”1Flytec’s founder appears to be a Brazilian national by the name ofOsni Arruda. As has been pointed out by other analysts, accordingto media reports, Arruda was arrested in Brazil in 2006, as part ofa “gang specializing in smuggling goods and [in] tax evasion.”2Flytec’s founder is a shady Another article singles out Flytec as a purveyor of the illicit goods.3character. According to Brazilian court documents, Arruda was accused ofdrug trafficking in 2009. The document reads, “There is concreteevidence that the investigated is involved in drug trafficking.”4 Onequestions why Ubiquiti is deeply involved in centers known forlaundering money on behalf of arms and drugs traffickers—businesses with much higher margins than network gear generallycan command.DiscompDiscomp is a Czech company listed as one of Ubiquiti’s Europeandistributors. Discomp and Ubiquiti have a long history. WhenUbiquiti first listed, it claimed Czech distributor Discomp wasworth 12% of its sales. This would put Discomp sales at roughlyUSD 42 mln. That is indeed an impressive showing in the Czechmarket. But Discomp’s 2012 filings with the Czech Ministry ofJustice cast serious doubt on these sales.1http://paraguay.usembassy.gov/volume licia/news/169079/?noticia CAI REI DO CONTRABANDO DE ELETRONICOS NO OI930516-EI15607,00-%20PF e Receita prendem contrabandistas de ao-trf-hc-osni-arruda.pdfDisclaimers: Last pageDecember 18, 201410

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comA Czech distributr reportedtiny sales to thegovernment there and yetshould be doing USD 42mln per year for Ubiquiti.Discomp financials. Source: Ministry of Justice of the Czech RepublicFor those of you who flunked high-school Czech, the abovedocument is an income statement showing that Discomp’s entirerevenue in 2012 was 614,644 Korunas, or roughly 27,000 USD.South America revenueAccording to Ubiquiti’s most recent 10-K, the company should bedoing over USD 100 mln per year in sales to South America. But inmost of the Latin American data that is available, Ubiquiti’sshipments are surprisingly small. According to Import Genius, thecompany had only USD 2.6 mln in shipments into Ecuador and USD1.6 mln in shipments to Colombia for the year ending in July 2014.This makes USD 100 mln a year to South America, while notimpossible, seem far-fetched.Moreover, though Paraguay does show substantial shipments,there is something very odd about Ubiquiti’s sales to Paraguay.In the last year Ubiquiti shipped approximately 8 mln lbs ofproduct to the United States. It reported USD 120 mln in USrevenue, yielding a value of USD 15 per pound of product. This isidentical to Ubiquiti’s Colombian shipments, which, at USD 1.6 mlnand 50,000 lbs, also came out to roughly USD 15/lb.Disclaimers: Last pageDecember 18, 201411

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comTable 2.Bills of lading don’t show alot of revenue in SouthAmerica.Ubiquiti shipments to Paraguay (lbs)Gross EC COMPUTERS INC.1,032,54513%4NET NETWORKING CORP735,6499%SYSCOM707,4109%INGRAM MICROEL PASO COMMUNICATION SYSTEMS,INC.SOLUTION BOX LLC496,7836%458,7746%353,2314%MicromJOSHUA FARRELL MICROCOMFULFILLMENTHUTTON COMMUNICATIONS OFCANADANETKROM TECHNOLOGIES INC.266,4003%111,2331%81,4381%59,5921%SISTEMAS Y SERVICIOS DE40,1080%SCSC DISTRIBUTION CENTER SCAN23,1600%DESARROLLOS DE INTERNET SA16,8850%Wisp-Router16,7950%LANDATEL DE MEXICO S.A. DE C.V.DOUBLERADIUS, INC 2022 VAN 00%TotalSource: Import GeniusBut the Paraguayan shipments, worth USD 13 mln, weighed in at3.4 mln lbs of product. This comes to only USD 3 per pound.Perhaps the Paraguayan market is simply hungry for low-endrouters. Or perhaps not all Ubiquiti revenue comes fromelectronics.Other distributorsMicrocom Technologies, based in Calabasas, California, is listed asone of Ubiquiti’s Master Distributors. Microcom has virtually noonline presence, so it is difficult to know what business thecompany does. The products on the website are almost all fromUbiquiti. The only sign of sales are from government contracts,from the Department of Defense as listed on usaspending.gov. Butthese seem to have gone away after 2012.Still other distributors do not appear to have the size one wouldexpect for a “Master Distributor.” Wisp-router Inc., for example, isDisclaimers: Last pageDecember 18, 201412

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .coma bit of a fixer-upper:The size and weight of theproducts also don’t matchup.Source: Google Maps (Photo taken June 2014, accessed December 18, 2014)It seems hard to believe that significant volumes of wirelessproduct are being run out of this establishment.Iran problemsUbiquiti announced in its IPO prospectus that the company wasunder investigation for violating U.S. sanctions against Iran.Eventually, the company was let off after paying a USD 504,225fine. But according to a simple Google search, the same Iraniandistributor continues to sell Ubiquiti products.Source: http://www.activenet.ir/shop/Disclaimers: Last pageDecember 18, 201413

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comRevenue overstatedAll told, we are forced to conclude that the overseas revenue islikely to be substantially overstated. If we take Flytec and Discompas an indication, foreign sales could be overstated by as much as25%.Ubiquiti appears to hold significant cash, but we do not believeMicrocom doesn’t look like that the cash could comes entirely from sales of networkinga major networking player. equipment.Accounting issuesA close look at Ubiquiti’s filings reveals that Ubiquiti holdssurprisingly high balances of cash overseas.Table 3.Ubiquiti Cash LocationUSD '000sCash & equityOverseas cash &equityDomestic cash &equity% US201176,3612012122,0602013227,8262014347,0972015 9,26017,42639,49760,21661%16%8%11%15%Source: Company filingsConsidering Ubiquiti derives between 20% and 40% of its revenueThe company seems still to from the U.S., it is puzzling why so much cash should be offshore.Given Ubiquiti’s low capex, there is really no reason for it to movebe selling to Iran. cash overseas. Another explanation could be that Ubiquiti’s U.S.operations are simply not as cash-generative as its overseasoperations. But why this would be is difficult to guess.Tax-free overseas?Ubiquiti does not appear to pay taxes overseas.There is probably not a single country in the world whose effectivetax rate is as low as 2.5%, and, unless all of Ubiquiti’s overseascustomers are in the Cayman Islands, the Bahamas, and Bermuda,such a tax rate seems impossible. It is also worth taking a look atUbiquiti’s competitors.Disclaimers: Last pageDecember 18, 201414

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comChart 6.160,000UBNT Overseas taxesUSD '000sTax 0001.0%40,0000.5%20,00000.0%20122013Foreign taxable incomeForeign tax rate2014Foreign provision for taxesSource: Company filingsTable 4.Overseas taxbasis905Provision forforeign taxes1,006Foreign %n/a375n/aUSD '000sRuckusNo taxes offshoreCompetitor overseas tax paymentsAerohiveSource: Company filingsEvery company save Ubiquiti pays taxes on overseas profits. Oneis entitled to suppose that Cisco has savvy tax attorneys, and evenit pays taxes of 10% of overseas profits. Once again, we are led toquestion the nature of Ubiquiti’s business.Deferred RevenueAnother red flag crops up in relation to Ubiquiti’s payment termswith distributors. According to our research, distributors generallypay Ubiquiti up front in cash, often fully 90 days in advance offulfillment.Table 5.Days deferred Ruckus*Source: Company filings, J Capital Research (Ruckus data reflects years 2012 and 2013)Disclaimers: Last pageDecember 18, 201415

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comIt is not uncommon for product suppliers in this industry to enjoygenerous terms from distributors. What is uncommon is for thoseterms not to filter into the balance sheet by way of deferredrevenue. Ubiquiti shows far lower DDR than peers. This could be aresult of aggressive revenue recognition. Indeed, if Ubiquiti wereto have similar DDR as peers, its revenue would have been roughly18% lower in 2014.Product and TechnologyIn Ubiquiti’s most recent transcript, Pera told listeners, “We're verymuch an R&D-driven company. I'm a product CEO. I'm not a salesCEO or a business CEO.” We find this statement puzzling givenUbiquiti’s relatively low R&D spend.Table 6.R&D Spend vs. PeersUSD 294,0005,488,0005,942,000Aerohive Networks16,08125,742Aruba Networks109,448139,746Ruckus Wireless43,82161,783169,328Source: Company filings, J Capital Research (Ruckus and Aerohive data reflects years 2011-2013)Chart 7.But everyone else seemsto pay.R&D as a percentage of revenues35%30%25%20%15%10%5%0%UbiquitiCisco (mlns)2012Aerohive*2013ArubaRuckus*2014*Aerohive and Ruckus figures are for fiscal year 2011 to 2013, rather than 2012 to 2014.Source: Company filingsAccording to company filings, Ubiquiti actually spends almostnothing on R&D.Disclaimers: Last pageDecember 18, 201416

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comPerhaps more remarkably, apart from the antennae products,virtually all Ubiquiti products can be found more cheaply fromWhere is the deferred major companies such as CISCO or DLink.revenue?Source: Newegg.comOur talks with industry professionals seem to confirm ambivalenceIndustry professionals toward Ubiquiti’s products. One WISP operator in Europe told us:express a dim view of“A lot of Ubiquiti’s products look better than they are.” ForUbiquiti’s technologies.example, Ubiquiti uses different reporting standards thancompetitors in describing its decibels, and claims “carriergrade” equipment, which is an overstatement. Moreover,“They use a lot of 'plastic' stuff in their hardware. Overtime, especially in sunny climates, or really cold climates,'plastic' becomes brittle and indeed, I stopped working withtheir stuff because I had several failures of their hardwareonly because of that.”Others have explained that Ubiquiti essentially acquires productand so products are somewhat inconsistent. As a networkingsolutions provider highly regarded in the U.S. networking industryput it:Disclaimers: Last pageDecember 18, 201417

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .com“Edge router and edge switch is not in-house developed anddeveloped on other people’s technology. Router product comesout of open-source product from Diata that was acquired byanother company a year and a half ago. Diata was buildingopen-source, low-cost router product. Ubiquiti uses that in theirrouting product. This makes the user experience very differentfrom the switching project.”CompetitionAnd even if it were asgood as advertised, the Ubiquiti’s only real competency seems to be in antennae. But evenfield is becoming more here, the company is currently under threat from new entrants.competitive. Ruckus announced on October 29 that it was coming out with itsXClaim product series. This is essentially a high-powered Wi-Fisolution that will compete directly with Ubiquiti’s signature Unifyproduct. For example, Xclaim’s outdoor product is comparable tothe Ubiquiti Unifi AP Outdoor Series, retailing for USD 489, isroughly comparable to the Xclaim Xo-1, which retails for only USD299.MimosaMimosa is another up-and-coming networking company. Accordingto one industry professional, “Mimosa is looking at doing a UBNTtype business but at a higher quality point Looking atundercutting UBNT.” He added that barriers to entry in theindustry are quite low.Indeed, Mimosa’s “massive capacity” access point will retail forabout USD 1,000 and host 250 to 1,000 users at a time. Longterm, we believe higher-end technology providers such as Mimosa,who are dropping their own price points, will erode the margin inlow-end products such as Ubiquiti’s.We believe there will still be a market for lower-end, Ubiquiti andRuckus type products in areas with low population density. ButMimosa (and similar technologies) will make Ubiquiti completelyuncompetitive for networks designed for more than 40-50 users.Corporate governanceCEO Pera has a reputation According to Forbes, CEO Robert J. Pera is a “34-year-old wireless5for being erratic. broadband visionary.” But according to a complaint filed n-has-billion-dollar-day/Disclaimers: Last pageDecember 18, 201418

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comUbiquiti cofounder Rommohan Malasani, Pera was emotionallyunstable. Malasani claims Pera strong-armed him intosurrendering much of his equity to Pera. The complaint reads:“Pera sought to renegotiate down Malasani’s ownershipinterest with an increase in Pera’s. Pera threatened to ‘stopUbiquiti’ unless Malasani agreed to the reducedownership Malasani did not believe he had any choice Hegave up his H1B1 visa when he left Centellax and wasdependent upon [Ubiquiti] for the application for the newvisa.”6The directors have Then there is the company’s revolving door of senior managers.unusually short tenures. When the company listed, the CFO was John Ritchie. Ritchie leftabruptly in 2013 to be replaced by Craig Foster. General CounselJessica Zhou quit in 2013 as well.At the same time, not a single independent board member hasserved for more than three years. When the company listed, itsdirectors included Charles Fitzgerald, Ronald A. Sege, Robert MVan Buskirk, J William Gurley, John L Ocampo, and Peter Chung.Buskirk was chair of the audit committee.One by one, these directors have left. Fitzgerald, Ocampo, andBuskirk—the entire audit committee—left in 2013. The new auditcommittee consists of Sege (the longest-serving independentboard member), Steven Altman, and Rafael Torres. Torres is theaudit committee chairman.This is a veritable revolving door of corporate governors. It meansthat Pera is more or less unaccountable.Middle KingdomUbiquiti manufacturers and ships virtually all of its products fromChina. According to the most recent 10-K:“We generally forward products directly from ourmanufacturers to our customers via logistics distributionhubs in Asia. Beginning in the quarter ended December 31,2012, our products were predominantly routed through athird party logistics provider in China.”Ubiquiti’s use of OEMs and third-party logistics providers havehistorically made their production difficult to track. However,6Malasani v. PeraDisclaimers: Last pageDecember 18, 201419

Ubiquiti Networks Inc. (NASDAQ UBNT)Anne Stevenson-YangMatt Lowenstein 86 139 1082 0535 1 646 400 .comrecently Ubiquiti announced plans to do its own manufacturing. Inits most recent 10-Q, Ubiquiti made an oblique reference to amanufacturing facility of its own, saying, “we lease approximately93,000 square feet of space in Suzhou, China, which is beingWhat went on in leased through June 16, 2016. These facilities would house ourproposed manufacturing facility in China.” Management addedShenzhen? slightly more color to these comments in the most recent earningstranscript, saying that the new factory would be used to acceleratetime to market, or essentially for prototyping. Reports by thecompany did not specify at what point these factories would startproduction or how much investment would go into them.According to Chinese press releases, Ubiquiti has promised toinvest fully USD 99 mln. Investment agreements in China aretypically inflated for the benefit of local governments, butUbiquiti’s company has registered capital of USD 40 mln,indicating that its investment will be rather substantial.7We took a lo

Ubiquiti Networks Inc. (NASDAQ UBNT) Anne Stevenson-Yang 86 139 1082 0535 anne@jcapitalresearch.com Matt Lowenstein 1 646 400 1424 matt@jcapitalresearch.com Disclaimers: Last page December 18, 2014 5 build Company background Ubiquiti is a manufacturer and supplier of networking equipment.